Q: Should California institute a 6.5 percent flat tax on corporate and personal income? The current top rate is about 13 percent for individuals and nearly 9 percent for most companies.

Panel's answer: Yes 2, No 6

This proposal, from economist Arthur Laffer, is offered as a way to stabilize the state’s budget cycles. The progressivity of an income tax like California’s causes tax revenues to surge during strong economic periods and crash during recessions, disproportionate to the change in income. Rather than a fix to boom and bust budget cycles, the problem would quickly become how to define income and what definitional “loopholes” will be cut or retained. Instead of worrying about distributing taxes “fairly,” or, allocating tax suffering equally, Californians should focus on the lowness of each tax, rather than the distribution of the burden.

Yes
81% (91)

No
19% (21)

While California taxes are clearly too onerous, a flat tax attempts to enforce arbitrarily defined “fair shares." The curious implicit assumption is government, not us, actually owns our earnings and property. Exemptions, deductions, and loopholes are therefore considered unfairly allocated subsidies. But how is keeping more of our own money unfair? The real point is we pay much too much in taxes. High tax rates discourage investment, jobs and productive activities, while making it difficult to amass vital savings for college, retirement, or starting a business. The much better solution for California’s financial morass is to lower everyone’s tax burdens.

For the first time in almost a decade, the state of California has a budget surplus. Laffer claims the flat tax would be revenue neutral at full employment, but it would likely lead to a deficit in the interim. California’s economy is improving significantly even with the existing tax structure, having added 270,000+ wage and salary jobs and 440,000+ total jobs in the last year. The latter number is nearly double the total for No. 2 Texas, which has no income tax, and includes the small businesses and sole proprietorships, which are supposedly impacted by the higher individual tax rates.

Everyone likes lower taxes, but how is the government going to pay its bills? The claim that tax cuts pay for themselves by growing incomes and the tax base has no support in the data. The historical experience has always been that when taxes are cut, deficits go up. Show me your spending cuts that the Legislature and governor are willing to sign into law and then we can talk about cutting taxes. But until that is agreed on, cutting taxes without addressing spending is irresponsible.

Art Laffer told me just before he moved to Tennessee some years ago that his motivation was to avoid California income taxes. I am not so sure that Art would move back just because we flattened it. I am all for tax simplification, but flattening the tax is not simplifying it, it is just redistributing the burden. I think it would be far more fruitful to concentrate on simplifying the U.S. income tax code, perhaps reducing it in favor of other taxes such as value added, than to be overly obsessed with state taxes. I know of some, but I do not believe that most business decisions are driven by our state tax code. Apple, for instance, is far more interested in avoiding federal than state taxes. I haven’t heard anything about them moving out of state.

I believe our state tax system is hurting our ability to retain major firms as they grow. Whether it is truly revenue neutral in the short run is doubtful. California would need to further tighten its belt and reduce expenditures, e.g., we could reform the laws that result in us holding more prisoners than anyone else in the world on a per capita basis. We have more invested in our prisons in California than in all of the K-12 schools combined. Lowering the income tax would also help retain wealthier households who sometimes find it a tax they can avoid by voting with their feet.

A flat tax would remove the complexity and many distortions from our tax code. The current system wastes resources evading taxes and contains all kinds of incentives that work counter to underlying economic forces. To retain progressivity, lower income households could be given tax credits or cash grants. A 6.5 percent tax rate may not be high enough to generate the necessary revenue. Arthur Laffer, the author of the recommendation, has often overestimated the “supply side” effects of tax cuts. Nevertheless, a move to a flat tax would help California and put it as a model for the nation.

California badly needs tax reform and simplification. The code is riddled with loopholes, exemptions, and preferences that make paying taxes costly and difficult, encouraging avoidance and evasion. The code clearly violates the principle of horizontal equity, that equal incomes should be taxed equally. But a flat tax that eliminated all of the exemptions, deductions and exclusions would meet horizontal equity but not vertical equity, the principle that higher incomes can afford to bear a higher burden of taxation than people at the low end of the income scale. Additionally, a flat tax right now would throw California back into deficit.